The existing Indian income-tax regime provides for complex provisions for computation of business income and tax. These provisions include a wide gamut of incentives and ‘disallowance’ (adjustments) in respect of deductibility of expenses, weighted deductions, tax holidays, tax deferrals, specific deductions, etc.
Implementation of such provisions often results in disputes in interpretation, leading to widespread litigation and a lengthy tax resolution and recovery process. An analysis of data for the past 10 years indicates that more than 37% of reported jurisprudence pertains to issues relating to tax adjustments in computation of business income.
Taxable income computed as per these provisions is taxed at the prescribed basic rate of 30%. Interestingly, the effective tax rate for the year ended March 31, 2014, was 23.22%, on account of various adjustments. Therefore, though it is perceived that the income-tax rates are uncompetitive as they are higher than that in most Asian countries, in reality, there is a significant variation—of nearly 7%, in the prescribed tax rate and the effective tax rate.
In order to achieve lower tax rate and to reduce disputes, it is imperative to devise a tax system which is precise and transparent. Such simple tax laws would contribute to ease of doing business in India, as these laws—as well as the compliances prescribed under them—would be both taxpayer- and revenue/administration-friendly and transparent.
In view of the above objective, India could have a tax regime, wherein income-tax is imposed directly on book profits, computed as per the profit-and-loss account (as reduced by unadjusted book loss) without any further adjustments. This would lead to abolition of computational provisions of business income, including incentives, tax holidaysExisting provisions on taxation of unexplained investments, expenses, credits and transfer-pricing are recommended to be continued to safeguard the interest of revenue and to act as a deterrent for any under-reporting of taxable income and other adjustments.
The rate to be prescribed under the new scheme may be the effective tax rate as on date, calibrated for a class of industry. Where the government wishes to further incentivise any specific class of industry, it can calibrate the rates or provide direct subsidies. Further, the regime may be applied to taxpayers mandated to maintain books of accounts in India and get them compulsorily audited as per the provisions of the Income-Tax Act, as most of the tax revenue is generated through such businesses.
During the transition phase from incentive (current) regime, the government could impose income-tax at reduced calibrated rates, catering to the requirements of specific classes of taxpayers and also ensuring that they remain revenue-neutral.
Existing provisions on taxation of unexplained investments, expenses, credits and transfer-pricing are recommended to be continued to safeguard the interest of revenue and to act as a deterrent for any under-reporting of taxable income. This would address the issue of India having an uncompetitive tax rate without causing a loss of revenue and also significantly reduce disputes.
The concern that due to flexibility permitted in the accounting system, the tax base of companies may not be precisely determined may arise. In this regard, it is important to understand that the impact of such flexibilities in accounting standards are mere timing differences which consequently result in tax deferrals. Therefore, over an economic cycle of a business (5-7 years), typically, all the income and expenses are recognised, even where differing accounting policies, due to flexible accounting treatment, are followed.
Also, there are various taxpayers contributing to the revenue in numerous business cycles qua different industries, and even the business cycles of taxpayers within an industry are seen simultaneously complementing and supplementing each other. Hence, if for some, it is tax deferrals, for others it would be reversal of tax deferrals, thereby mitigating any loss in collections.
Another concern may be that income not accounted for in the books of accounts would escape taxation. Here, it may be noted that even in the current tax system, the starting point for tax computation is book profits and then numerous adjustments are to be applied.
Implementation of these provisions would lead to widespread transparency in the tax system and would ensure simple, easy to understand and time-saving tax compliances. It would result in abolishing approximately 90 sections of the existing I-T Act, spread over nearly 200 pages. Also, abolishing of tax incentives and at the same time implementing calibrated tax rates would help in minimising tax litigation in India, thereby promoting a stable tax environment.
The author is leader (direct tax), PwC India. Views are personal